Crawling Before Walking

It must be tough, being a swap execution facility (SEF) operator. The things are enormously expensive to run, and if you're not Bloomberg, Tradeweb, or some of the larger interdealer brokers (IDBs) and information providers, you're already facing an uphill battle from the start.

Because, as everyone out of the dozen people I spoke to for my feature this month on how SEFs have done to date agreed, volume is king. Yes, you can have nifty compression tools, the occasional instrument that can't be found on other venues, and all kinds of technology to give away for free, but if you don't have liquidity on your books, then you're not going anywhere.

It doesn't help that volumes haven't been near the state they were before. Indeed, they imploded over the summer, but the recent upturn suggests that this was just reflective of seasonal changes in market conditions over the hot months than just because it's SEF trading, per se. Is it just the buy side not engaging properly? Maybe that's part of it. But it's also the hybridized methods of trading, that confluence between voice and screen that makes the statistics lie. As one of my sources said, a deal might be arranged and negotiated entirely by phone, and just executed on the SEF, which captures the details and reports it to a trade repository. Is that truly, then, an electronic trade in the spirit of the regulation as well as the letter of it?

That's not a criticism, of course. Electronic isn't necessarily better by default, and it still fulfils the central role of increased transparency. It's just that it's difficult to truly measure the penetration of modernizing influences such as screen trading, let alone the wider difficulties with taking something as varied as derivatives trading and trying to standardize it.

One other observation I noted, which didn't make it into the feature as such, was the language that people used when talking about the number of SEFs. A year ago, it was all about consolidation ─ now, not so much. People were more comfortable saying that some will simply go bust, and not necessarily be taken over, particularly if they don't offer anything revolutionary. The problem for many IDBs and others is that they almost have to offer the service, and with clearing access a consideration along with SEF rates, it might be less of a fiscal pain point to operate it yourself than relying on a competitor. For the smaller vendors, who are struggling to gain traction in a busy market, maybe not so much.

I still have a vast amount of material from the interviews, so I'll continue to publish analysis pieces over the next few weeks to complement the story. If you have views on the topic, please feel free to get in touch.